Friday, August 16, 2013

John Maynard Keynes, Investment Innovator

When I think of John Maynard Keynes as an investor, a few images and thoughts run through my mind. 

One image is an insouciant and self-satisfied global citizen, making global investments while sipping tea in bed. In his 1919 essay, The Economic Consequences of the Peace, Keynes painted a picture of what the world economy looked like before 1914. He wrote:

"The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises of any quarter of the world, and share, without exertion or trouble, in their prospective fruits and advantages; or he could decide to couple the security of his fortunes with the good faith of the townspeople of any substantial municipality in any continent that fancy or information might recommend."

A second thought is how very difficult it is to make money in the stock market, because you are essentially trying to pick the stock today that other people think will want to buy at a higher price tomorrow. In the General Theory, Keynes offers a famous metaphor:

"[P]rofessional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole, not those faces which he himself finds prettiest, but those which he thinks likeliest to match the fancy of the other competitors, all of whom are looking at the problem from the same point of view."
 Finally, I also think of Keynes as a legendarily successful investor, and in particular how he grew the endowment of King's College.  I don't think he did all of it sipping tea in bed, nor by thinking about investing as a beauty contest. In fact, I had no real idea how Keynes succeeded as an investor until reading the article by David Chambers and Elroy Dimson, "Retrospectives: John Maynard Keynes, Investment Innovator," in the most recent issue of the Journal of Economic Perspectives. (Like all articles appearing in  JEP, it is freely available on-line courtesy of the American Economic Association. Full disclosure: I'm the managing editor of the journal.) Here are a few insights from their article (as always, with citations and notes omitted for readability):

Over the entire time period, Keynes was wildly successful as an investor.
"When John Maynard Keynes managed the endowment of King’s College at Cambridge University, the actively managed part of his portfolio beat the performance of the British common stock index by an average of 8 percentage points per year from 1921 to 1946."

Keynes was one of the first institutional investors to move heavily into stocks. 
"Keynes was among the first institutional managers to allocate the majority of his portfolio to the then-alternative asset class of equities. In contrast, most British (and American) long-term institutional investors of a century ago regarded ordinary shares or common stocks as unacceptably risky and shunned this asset class in favor of fixed income and real estate. ... To our knowledge, no other Oxbridge colleges made a substantial allocation to equities until the second half of the twentieth century. In the United States, the largest university endowments allocated less than 10 percent to
common stock in the 1920s (on a historical cost-weighted basis), and this total only rose above 20 percent in the late 1930s."
However, Keynes performed poorly as an investor for the first eight years or so. 
"The year-by-year results also show that Keynes underperformed [a comparable market index] in only six out of the 25 financial years and that four of those years occurred in the first eight years of his management of the Discretionary Portfolio. By August 1929, he was lagging the UK equity market by a cumulative 17.2 percent since inception. In addition, he failed to foresee the sharp fall in the market the following month."

Keynes dramatically shifted his investment philosophy around 1930, switching from a market-timing macroeconomic approach to becoming one of the first "value" investors. 
"Keynes independently championed value investing in the United Kingdom at around the same time as Benjamin Graham was doing so in the United States. Both Keynes’ public statements and his economic theorizing strongly suggest that he did not believe that “prices of securities must be good indicators of value” (Fama 1976). Beginning as a top-down portfolio manager, seeking to time his allocation to stocks, bonds, and cash according to macroeconomic indicators, he evolved into a bottom-up investor from the early 1930s onwards, picking stocks trading at a discount to their “intrinsic value”—terminology he himself employed. Subsequently, his equity investments began to
outperform the market on a consistent basis."

Keynes' overall portfolio was far from an index fund: he concentrated on a relatively small number small and medium-sized firms in certain industries. 
"[T]he majority of his UK equity holdings were concentrated in just two sectors, metal mining—tin mining stocks in the 1920s and gold mining stocks in the following decade—and commercial and industrial firms ...  Banking carried an index weight of 20 percent, and Keynes had little or no exposure in this sector. ... Keynes’ substantial weighting in commercial and industrial stocks began in the early and mid-1920s with a diversified portfolio of industrial names. However, soon thereafter he concentrated his exposure in this sector on the two leading British automobile stocks, Austin Motors and Leyland Motors. In the context of the time, these would have been viewed as “technology” stocks. In terms of firm size, Keynes had a decided tilt towards mid-cap and small-cap stocks."